On
May 19, 1987, a short article in The Wall
Street Journal reported that ZZZZ Best Company, Inc., of Reseda, California,
had signed a contract for a $13.8 million in­surance restoration project. This
project was just the most recent of a series of large restoration jobs obtained
by ZZZZ Best (pronounced “zee best”) Company. Located in the San Fernando
Valley of southern California, ZZZZ Best had begun operations in the fall of
1982 as a small, door-to-door carpet cleaning operation. Under the direction of
Barry Minkow, the ambitious sixteen-year-old who founded the company and
initially operated it out of his parents’ garage, ZZZZ Best experienced
explosive growth in both revenues and profits during the first several years of
its existence. In the three-year period from 1984 to 1987, the com­pany’s net
income surged from less than $200,000 to more than $5 million on reve­nues of
$50 million.

When
ZZZZ Best went public in 1986, Minkow and several of his close associ­ates
became multimillionaires overnight. By the late spring of 1987, Minkow’s stock
in the company had a market value exceeding $100 million, and the total market
value of ZZZZ Best surpassed $200 million. The youngest chief executive officer
in the nation enjoyed the “good life,” which included an elaborate home in
an exclusive suburb of Los Angeles and a fire-engine red Ferrari. Minkow’s
charm and entrepreneurial genius made him a sought-after commodity on the
television talk show circuit and caused the print and visual media to tout him
as an example of what America’s youth could attain if they would only apply
them­selves. During an appearance on The Oprah Winfrey Show in April 1987, Minkow exhorted his peers with
evangelistic zeal to “Think big, be big” and encouraged them to adopt his
personal motto, “The sky is the limit.”

Less
than two years after his appearance on The Oprah Winfrey Show, Barry Minkow began serving a
twenty-five-year prison sentence. Tried and convicted on fifty-seven counts of
securities fraud, Minkow had been exposed as a fast­talking con artist who
bilked his closest friends and Wall Street out of millions of dollars. Federal
prosecutors estimate that, at a minimum, Minkow cost investors and creditors
$100 million. The company that Minkow founded was, in fact, an elaborate Ponzi
scheme. The reported profits of the firm were nonexistent and the
huge restoration contracts, imaginary. As one journalist reported, rather than
building a corporation, Minkow constructed a hologram of a corporation. In July
1987, just three months after the company’s stock had reached a market value
of $220 million, an auction of its assets netted only $62,000.

Unlike
most financial frauds, the ZZZZ Best scam was perpetrated under the watchful eye
of the Securities and Exchange Commission (SEC). The scrutiny of the SEC, one of
the largest Wall Street brokerage houses, a large and reputable West Coast law
firm that served as the company’s general counsel, and an inter­national
public accounting firm had failed to uncover Minkow’s daring scheme.
Ultimately, the persistence of an indignant homemaker who had been bilked out of
a few hundred dollars by ZZZZ Best resulted in Minkow being exposed as a fraud.

How
a teenage flimflam artist could make a mockery of the complex regula­tory
structure that oversees the U.S. securities markets was the central question
posed by a congressional subcommittee that investigated the ZZZZ Best debacle.
Representative John D. Dingell, chairman of the U.S. House Committee on Energy
and Commerce, pointed out, “The ZZZZ Best prospectus told the public that
revenues and earnings from insurance restoration contracts were skyrocket­ing
but did not reveal that the contracts were completely fictitious. Where were the
independent auditors and the others that are paid to alert the public to fraud
and deceit?”[1]
Like many other daring financial frauds, the ZZZZ Best scandal caused Congress
to reexamine and modify the maze of rules that regulate finan­cial reporting
and serve as the foundation of the U.S. system of corporate over­sight.
However, Daniel Akst, a reporter for The
Wall Street Journal who played a large role in exposing Minkow, suggests
that another ZZZZ Best is inevitable: "Changing the accounting rules and
securities laws will help, but every now and then a Barry Minkow will come
along, and ZZZZ Best will happen again. Such frauds are in the natural order of
things, I suspect, as old and enduring as human needs."[2]

THE
EARLY HISTORY OF ZZZZ BEST COMPANY

Barry
Minkow was introduced to the carpet cleaning industry at the age of twelve by
his mother, who helped make ends meet by working as a telephone solicitor for a
small carpet cleaning firm. Although the great majority of companies in the
carpet cleaning industry are legitimate, the nature of the business attracts a
dis­proportionate number of seedy characters. There are essentially no barriers
to entry: no licensing requirements, no apprenticeships to be served, and only a
minimal amount of start-up capital needed. A sixteen-year-old youth with a
dri­ver’s license can easily become what industry insiders refer to as a
“rug sucker,” which is exactly what Minkow did when he founded ZZZZ Best
Company.

Minkow
quickly recognized that carpet cleaning was a difficult way to earn a
livelihood. The ease of entry into the field meant that cutthroat competition
was hue of prevalent within the industry. Customer complaints, bad checks, and
nagging vendors demanding payment complicated the young entrepreneur’s life.
Within months of striking out on his own, Minkow faced the ultimate nemesis of
the small businessperson: a shortage of working capital. Because of his age and
the ~table fact that ZZZZ Best was only marginally profitable, local banks
refused to loan inter- him money Ever resourceful, the brassy teenager came up
with his own innova­tive ways to finance his business: check kiting, credit
card forgeries, and the staging of thefts to fleece his insurance
company. Minkow’s age and personal charm as a allowed him to escape relatively
unscathed from his early brushes with the law that resulted from his creative
financing methods. The ease with which the “sys­~ula- tern” could be beaten
encouraged him to exploit it on a broader scale.

Throughout
his short business career, Minkow realized the benefits of having an
extensive social network of friends and acquaintances. Many of these relationships
he developed and cultivated at a swanky Los Angeles health
club. Soon after becoming a friend of Tom Padgett, an insurance claims adjuster,
Minkow devised a scheme to exploit that friendship. Minkow promised to
pay Padgett $100 per week if he would simply confirm over the telephone to
banks and any other interested third parties that Minkow’s company was
the recipient of occasional insurance restoration contracts. Ostensibly,
these contracts had been obtained by an- Minkow to clean and do minor remodeling
work on properties damaged by fire, storms, or other catastrophes. The
gullible Padgett was led to believe that the sole a purpose of such
confirmations was to allow Minkow to circumvent much of the bureaucratic red
tape in the insurance industry.

From
this beginning, the ZZZZ Best fraud blossomed. Initially, the insurance restoration work, which was totally fictitious, was a small sideline that Minkow
used to generate paper profits and revenues to convince bankers to loan him
money Minkow’s phony financial statements served their purpose, and he
ex­panded his operations by opening several carpet cleaning outlets across the
San Fernando Valley Minkow soon realized that there was no need to tie his
future to the cutthroat carpet cleaning
industry when he could literally dictate the size and profitability of his
insurance restoration ‘‘business.’’ Within a short period of time,
insurance restoration, rather than carpet cleaning, became the major source ofrevenue appearing on the ZZZZ Best income statements.

Minkow’s
"the sky is the limit" philosophy drove him to be even more
innova­tive. The charming young entrepreneur began using his phony financial
state­ments to entice wealthy individuals in his ever-expanding social network
to invest in ZZZZ Best. Eventually, Minkow
recognized that the ultimate scam would be to take his company public, a move
that would allow him to tap the bank accounts of investors nationwide.

GOING
PUBLIC WITH ZZZZ BEST

The
decision to take ZZZZ Best public meant that Minkow
no longer was able to completely control his firm’s financial disclosures.
Registering with the SEC required auditors, investment bankers, and outside
attorneys to peruse the ZZZZ Best financial statements. Federal securities laws
impose a due diligence obligation on these parties; that is, under the federal
securities laws, parties asso­ciated with a securities registration statement
must attempt to determine that the information therein is materially accurate.
ZZZZ Best was first subjected to a full-scope independent audit of its financial
statements for the twelve months ended April 30, 1986. George Greenspan, the
sole practitioner who performed that audit, confirmed the existence of ZZZZ
Best’s major insurance restoration contracts by contacting Tom Padgett, the
principal officer of Interstate Appraisal Services, which reportedly contracted
the jobs out to ZZZZ Best. By this time, Padgett was an active and willing
participant in Minkow’s fraudulent schemes. Minkow had established Interstate
Appraisal Services and Assured Property Management for the sole purpose of
generating fake insurance restoration contracts for ZZZZ Best.

According
to Greenspan’s testimony before the congressional subcommittee that
investigated the ZZZZ Best scandal, he not only confirmed the existence of the
insurance restoration jobs but also obtained and reviewed copies of all key
documents regarding those jobs. In addition, Greenspan performed various
ana­lytical procedures to determine that the company’s key financial ratios
were in line with industry averages. However, Greenspan did not inspect any of
the in­surance restoration sites. The congressional subcommittee was surprised,
if not alarmed, that he had not personally visited at least a few of the job
sites.

CONGRESSMAN
LENT: Mr. Greenspan, I am interested in
the SEC Form 5-1 that ZZZZ Best Company filed with the SEC.... You say in that
report that you made your examination in accordance with generally accepted
auditing stan­dards and accordingly included such tests of the accounting
records and other auditing procedures as we consider necessary in the
circumstances…..You don’t say in that statement that you made any personal
on-site inspections.

MR.
GREENSPAN: It’s not required. Sometimes
you do; sometimes you don’t. I was satisfied that these jobs existed and I was
satisfied from at least six differ­ent sources, including payment for the job.
What could you want better than that?

CONGRESSMAN
LENT: Your position is that you are an
honest and reputable ac­countant.

MR.
GREENSPAN: Yes, sir.

CONGRESSMAN
LENT: You were as much a victim as some
of the investors in this company?

MR.
GREENSPAN: I was a victim all right.... I
am as much aghast as anyone. And every night I sit down and say, why didn’t I
detect this damned fraud.

RETENTION
OF ERNST & WHINNEY BY ZZZZ BEST

Shortly
after Greenspan completed his audit of ZZZZ Best’s April 30, 1986, fi­nancial
statements, Minkow dismissed him and retained Ernst & Whinney to per­form
the following year’s audit. Apparently, ZZZZ Best’s investment broker
requested that Minkow obtain a Big Eight accounting firm to enhance the
credi­bility of the company’s financial statements. About the same time, and
for the same reason, Minkow retained a high-profile Los Angeles law firm to
represent ZZZZ Best as its legal counsel.

The
congressional subcommittee asked Greenspan what information he pro­vided to
Ernst & Whinney regarding his former client. In particular, the
subcom­mittee was interested in whether Greenspan had discussed the insurance
restoration contracts with the new auditors.

CONGRESSMAN
WYDEN: Mr. Greenspan, in September 1986,
Ernst & Whinney came on as the new independent accountant for ZZZZ Best.
What did you communicate to Ernst & Whinney with respect to the restoration
contracts?

MR.
GREENSPAN: Nothing. I did—there was
nothing because they never got in touch with me. It’s protocol for the new
accountant to get in touch with the old accountant. They never got in touch with
me, and it’s still a mystery to me.

Representatives
of Ernst & Whinney later testified that they did, in fact, com­municate
with Greenspan prior to accepting ZZZZ Best as an audit client. However, Ernst
& Whinney’s testimony did not disclose the nature or content of that
communication, and Greenspan was not recalled to rebut Ernst & Whinney’s
testimony on this issue.

Exhibit
1 contains the engagement letter signed by Ernst & Whinney and Barry Minkow
in September 1986. The engagement letter outlined four services that the audit
firm intended to provide ZZZZ Best: a review of the company’s financial
statements for the three-month period ending July 31, 1986; assistance in the
preparation of a registration statement to be filed with the SEC; a comfort
letter to be submitted to ZZZZ Best’s underwriters; and a full-scope audit for
the fiscal year ending April 30, 1987. Ernst & Whinney completed the review,
provided the comfort letter to ZZZZ Best’s underwriters, and apparently
assisted the company in preparing the registration statement for the SEC;
however, Ernst & Whinney never completed the 1987 audit. The audit firm
resigned on June 2, 1987, amid growing concerns that ZZZZ Best’s financial
statements were grossly misstated.

The
congressional subcommittee investigating the ZZZZ Best fraud questioned Ernst
& Whinney representatives at length regarding the bogus insurance
restoration contracts—contracts that accounted for 90 percent of ZZZZ Best’s
re­ported profits. The congressional testimony disclosed that Ernst &
Whinney re­peatedly insisted on visiting several of the largest of these
contract sites, and that Minkow and his associates attempted to discourage such
visits. Eventually, Minkow realized that the auditors would not relent and
agreed to allow them to visit certain of the restoration sites, knowing full
well that none of the sites actu­ally existed.

To
convince Ernst & Whinney that the insurance restoration contracts were
au­thentic, Minkow and his associates devised a series of sting operations. In
the late fall of 1986, Larry Gray, the engagement audit partner for ZZZZ Best,
insisted on visiting a restoration site in Sacramento on which ZZZZ Best had
reported ob­taining a multimillion-dollar contract. Minkow sent two of his
cohorts to Sacramento to find a large building under construction or renovation
that would provide a plausible site for a restoration contract. Gray had visited
Sacramento weeks earlier to search for the site that Minkow had refused to
divulge. As chance would have it, the building chosen by the ZZZZ Best
conspirators was the same one Gray had identified as the most likely site of the
insurance restoration job.

EXHIBIT
1 Ernst & Whinney's ZZZZBest
Engagement Letter

September
12,1986

Mr.
Barry Minkow

Chairman
of the Board

ZZZZ
Best Co., Inc.

7040
Darby Avenue

Reseda,
California

Dear
Mr. Minkow:

This
letter is to confirm our understanding regarding our engagement as
independent accoun­tants of ZZZZ BEST CO., INC. (the Company) and the
nature and limitations of the services we will provide.

We
will perform the following services:

1.
We will review the balance sheet of the Company as of July 31, 1986, and
the related statements of income, retained earnings, and changes in
financial position for the three months then ended, in accordance with
standards established by the American Institute of Certified Public
Accountants. We will not perform an audit of such financial statements,
the objective of which is the expressing of an opinion regarding the
financial statements taken as a whole, and, accord­ingly, we will not
express an opinion on them. Our report on the financial statements is
presently expected to read as follows:

“We
have made a review of the condensed consolidated balance sheet of ZZZZ
BEST CO., INC. and subsidiaries as of July 31,1986, and the related
condensed consolidated statements of income and changes in financial
position for the three-month period ended July 31, 1986, in accordance
with standards established by the American Institute of Certified Public
Accountants. A review of the condensed consolidated financial statements
for the comparative period of the prior year was not made.

A
review of financial information consists principally of obtaining an
understanding of the system for the preparation of interim financial
information, applying analytical review proce­dures to financial data,
and making inquiries of persons responsible for financial and account­ing
matters.

It
is substantially less in scope than an examination in accordance with
generally accepted auditing standards, which will be performed for the
full year with the objective of expressing an opinion regarding the
financial statements taken as a whole. Accordingly, we do not ex­press
such an opinion.

Based
on our review, we are not aware of any material modifications that should
be made to the condensed consolidated interim financial statements
referred to above for them to be in conformity with generally accepted
accounting principles”

Our
engagement cannot be relied upon to disclose errors, irregularities, or
illegal acts, including fraud or defalcations, that may exist. However, we
will inform you of any such matters that come to our attention.

2.
We will assist in the preparation of a Registration Statement (Form S-1)
under the Securities Act of 1933 including advice and counsel in
conforming the financial statements and related information to Regulation
S-X.

3.
We will assist in resolving the accounting and financial reporting
questions which will arise as a part of the preparation of the
Registration Statement referred to above.

4.
We will prepare a letter for the underwriters, if required (i.e., a
Comfort Letter), bearing in mind the limited nature of the work we have
done with respect to the financial data.

5.
We will examine the consolidated financial statements of the Company as of
April 30, 1987, and for the year then ended and issue our report in
accordance with generally accepted auditing standards approved by the
American Institute of Certified Public Accountants. These standards
contemplate, among other things, that (1) we will study and evaluate the
Company’s internal con­trol system as a basis for reliance on the
accounting records and for determining the extent of our audit tests; and
(2) that we will be able to obtain sufficient evidential matter to afford
a rea­sonable basis for our opinion on the financial statements. However,
it should be understood that our reports will necessarily be governed by
the findings developed in the course of our examina­tion and that we
could be required, depending upon the circumstances, to modify our
reporting from the typical unqualified opinion. We will advise you, as our
examination progresses, if any developments indicate that we will be
unable to express an unqualified opinion. Because our examination will be
performed generally on a test basis, it will not necessarily disclose
irregularities, if any, that may exist. However, we will promptly report
to you any irregularities which our exami­nation does disclose.

Our
fees will be derived from our customary rates for the various personnel
involved plus out-of-pocket expenses. Certain factors can have an effect
on the time incurred in the conduct of our work. Among these are the
general condition of the accounting records, the amount of assis­tance
received from your personnel in the accumulation of data, the size and
transaction volume of business, any significant financial reporting issues
that arise in connection with the SEC’s review of the S-1, as well as
unforeseen circumstances. Based upon our current understanding of the
situation, the amount of our proposed billing for the various services
which we will be provid­ing are estimated to be:

Review
of the July 31, 1986 financial statements $5,000—$7,500

Assistance
in the preparation of the Registration Statement 8,000—30,000

Comfort
Letter 4,000—6,000

Audit
of financial statements as of April 30, 1987 24,000—29,000

We
will invoice you each month for the time charges and expenses incurred in
the previous month and such invoices are due and payable upon
presentation.

Larry
D. Gray, Partner, is the Client Service Executive assigned to the
engagement. Peter Griffith, Audit Manager, and Michael McCormick, Tax
Manager, have also been assigned.

We
greatly appreciate your engagement of our firm; if you have any questions,
we shall be pleased to discuss them with you. Please indicate your
acceptance of the above arrangements by signing and returning the enclosed
copy. This letter constitutes the full understanding of the terms of our
engagement.

Very
truly yours.

Ernst
& Whinney

By
Larry D. Gray, Partner

ACCEPTED:

ZZZZ
BEST CO.. INC.

Barry
J. Minkow, Chairman of the Board

(signed)

9—16—86

Minkow’s
two confederates, while posing as leasing agents of a property man­agement
firm, convinced the supervisor of the construction site to provide the keys to
the building one weekend on the pretext that a large prospective tenant wished
to tour the facility. Prior to the arrival of Larry Gray and an attorney
rep­resenting ZZZZ Best’s law firm, Minkow’s subordinates visited the site
and placed placards on the walls at conspicuous locations indicating that ZZZZ
Best was the contractor for the building renovation. No details were overlooked
by Minkow’s lieutenants; they even paid the building’s security officer to
greet the visitors and demonstrate that he was aware in advance of their tour of
the site and its purpose. Although the building had not been damaged and instead
was simply in the process of being completed, the sting operation went off as
planned. Exhibit 2 presents the memorandum Gray wrote describing his tour of the
building—a memorandum that was included in Ernst & Whinney’s ZZZZ Best
workpapers.

Congressional
investigators quizzed Gray regarding the measures he took to confirm that ZZZZ
Best actually had a restoration contract on the Sacramento building. They were
particularly concerned that he never discovered the building had not suffered
several million dollars in damages a few months earlier, as claimed by ZZZZ Best
personnel.

CONGRESSMAN
LENT: . . . did you check the building permit or construction permit?

MR.
GRAY: No, sir. That wouldn’t be necessary to accomplish what I was setting out
to accomplish.

CONGRESSMAN
LENT: And you did not check with the building’s owners to see if an insurance
claim had been filed?

MR.
GRAY: Same answer. It wasn’t necessary. I had seen the paperwork inter­nally
of our client, the support for a great amount of detail. So, I had no need to
ask—to pursue that.

CONGRESSMAN
LENT: You understand that what you saw was not anything that was real in any
sense of the word?... You are saying you were duped, are you not?

MR.
GRAY: Absolutely.

Congressional
testimony disclosed that one of the visitations by Ernst & Whinney forced
ZZZZ Best to lease a partially completed building and to hire subcontractors to
do a considerable amount of work on the site. In total, ZZZZ Best spent several
million dollars for the sole purpose of deceiving its auditors.

The
success of the bogus site visitations was due in large part to Minkow’s
in­sistence that Ernst & Whinney and ZZZZ Best’s law firm sign
confidentiality agreements before the visits were made. A copy of one such
agreement is shown in Exhibit 3. Members of the congressional subcommittee were
troubled by the following stipulation of the confidentiality agreement: “We
will not make any follow-up telephone calls to any contractors, insurance
companies, the building owner, or other individuals involved in the restoration
contract.” This restriction effectively precluded the auditors and attorneys
from corroborating the insurance restoration contracts with independent third
parties.

At
our request, the Company arranged for a tour of the job site in Sacramento
on November 23rd [1986]. The site (not previously identified for us
because of the confidentiality agreement with their customer) had been
informally visited by me on October 27. I knew approximately where the job
was, and was able to identify it through the construction activity going
on.

On
November 23, Mark Morse accompanied Mark Moskowitz of Hughes Hubbard
& Reed and myself to Sacramento. We visited first the offices of the
Building Manager, Mark Roddy of Assured Property Management, Inc Roddy was
hired by the insurance company (at Tom Padgett’s suggestion according to
Morse) to oversee the renovation activities and the leasing of the space.
Roddy accompanied us to the building site.

We
were informed that the damage occurred from the water storage on the roof
of the building. The storage was for the sprinkler systems, but the water
was somehow released in total, causing construction damage
to floors 17 and 18, primarily in bathrooms which were directly under the water holding tower, then the water
spread out and flooded floors 16 down through about 5 or 6, where it started to
spread out even further and be held in pools.

We
toured floor 17 briefly (it is currently occupied by a law firm) then
visited floor 12 (which had a considerable amount of unoccupied space) and
floor 7. Morse pointed out to us the carpet, painting and clean up work
which had been ZZZZ Best’s responsibility. We noted some work not done
in some other areas (and in unoccupied tenant space). But per Mark, this
was not ZZZZ Best’s responsibility, rather was work being undertaken by
tenants for their own purposes.

Per
Morse (and Roddy) ZZZZ Best’s work is substantially complete and has
passed final inspec­tion. Final sign-off is expected shortly, with final
payment due to ZZZZ Best in early December.

Morse was well versed in the building history and
in the work scope for ZZZZ Best. The tour was beneficial in gaining
insight as to the scope of the damage that had occurred and the type of
work that the Company can do.

In
connection with the proposed public offering (the Offering) of Units
consisting of common stock and warrants of ZZZZ Best Co~, Inc. (the
Company), we have requested a tour of the site of the Company’s
insurance restoration project in Sacramento, California, Contract No.
18886. Subject to the representations and warranties below, the Company
has agreed to arrange such a tour, which will be conducted by a
representative of Assured Property Management Inc. (the Representative),
which company is unaffiliated with Interstate Appraisal Services. The
under­signed, personally and on behalf of Ernst & Whinney, hereby
represents and warrants that:

1.We will not disclose the location of such building, or any other
information with respect to the project or the building, to any third
parties or to any other members or employees of our firm;

2.We will not make any follow-up telephone calls to any contractors,
insurance companies, the building owner, or other individuals involved in
the restoration project;

3.We will obey all on-site safety and other rules and regulations
established by the Company, Interstate Appraisal Services and the
Representative;

4.The undersigned will be the only representative of this Firm
present on the tour. This Confidentiality Letter is also being furnished
for the benefit of Interstate Appraisal Services, to the same extent as if
it were furnished directly to such company.

RESIGNATION
OF ERNST & WHINNEY

Ernst
& Whinney resigned as ZZZZ Best’s auditor on June 2, 1987, following a series
of disturbing events that caused the firm to question the integrity of
Minkow and his associates. First, Ernst & Whinney was alarmed by a Los
Angeles Times article in mid-May 1987 that revealed Minkow had been involved
in a string of credit card forgeries as a teenager. Second, on May 28, 1987,
ZZZZ Best issued a press release, without consulting or notifying Ernst &
Whinney, that reported record profits and revenues. The purpose of this press
release was to restore in­vestors’ confidence in the company—confidence
that had been shaken by the damaging Los Angeles Times story. Third, and
most important, on May 29, Ernst & Whinney auditors discovered evidence
supporting allegations made several weeks earlier by a third party informant
that ZZZZ Best’s insurance restoration business was fictitious. The informant
had contacted Ernst & Whinney in April 1987 and asked for $25,000 in
exchange for information proving that one of the firm’s clients was engaging
in a massive fraud. Ernst & Whinney refused to pay the sum, and the
individual recanted shortly thereafter, but not until the firm de­termined that
the allegation involved ZZZZ Best. (Congressional testimony dis­closed that the
individual recanted because of a bribe paid to him by Minkow.) Despite the
retraction, Ernst & Whinney questioned Minkow and ZZZZ Best’s board of
directors regarding the matter, at which point Minkow denied ever knowing the
individual who had made the allegation. On May 29, 1987, however, Ernst &
Whinney auditors discovered several cancelled checks that Minkow had personally
written to the informant several months earlier.

Because
ZZZZ Best was a public company, the resignation of its independent auditor was
required to be reported to the SEC in an 8-K filing. One purpose of this
requirement is to alert investors and creditors of the circumstances that may
have led to the change in auditors. At the time, SEC registrants were allowed
fif­teen days to file the 8-K auditor change announcement. After waiting the
maxi­mum permissible time, ZZZZ Best reported the change in auditors but,
despite Ernst & Whinney’s insistence, made no mention in the 8-K of the
fraud allegation that had been subsequently recanted. The SEC’s rules that
were in effect at the time also required a former audit firm to file an exhibit
letter to a former client’s 8-K commenting on the 8-K’s accuracy and
completeness. Former audit firms were given thirty days to file the exhibit
letter, which was the length of time Ernst & Whinney waited before
submitting its exhibit letter to the SEC. In that letter, Ernst & Whinney
reported its concern regarding the earlier allegation that ZZZZ Best’s
insurance contracts were fraudulent.

The
congressional subcommittee was alarmed that forty-five days passed be­fore the
charges of fraudulent misrepresentations in ZZZZ Best’s financial state­ments
were disclosed to the public. By the time Ernst & Whinney’s exhibit letter
was released to the public, ZZZZ Best had filed for protection from its
creditors under Chapter 11 of the federal bankruptcy code. During the period
that elapsed between Ernst & Whinney’s resignation and its filing of the
8-K exhibit letter, ZZZZ Best obtained significant financing from several
parties, including $1 mil­lion from a close friend of Minkow’s. These parties
never recovered the funds in­vested in, or loaned to, ZZZZ Best. As a direct
result of the ZZZZ Best debacle, the SEC shortened the length of time that
registrants and their former auditors may wait before filing the required
auditor change documents with the SEC.

The
congressional subcommittee also quizzed Ernst & Whinney representa­tives
regarding the information they disclosed to Price Waterhouse, the audit firm
hired by Minkow to replace Ernst & Whinney.[3]Congressman
Wyden was concerned
that Price Waterhouse had not received all relevant information thatErnst & Whinney had in its possession regarding its former
client.

CONGRESSMAN
WYDEN: I am going to
insert into the record at this point a memo entitled “Discussion with
successor auditor,” written by Mr. Gray and dated June 9, 1987. Regarding a
June 4 meeting, Mr. Gray, with Dan Lyle of Price Waterhouse concerning the
integrity of ZZZZ Best’s management, you stated that you had no reportable
disagreements and no reservations about manage­ment integrity pending the
results of a board of directors’ investigation. Then you went on to say that
you resigned because, and I quote here: “We came to a conclusion that we
didn’t want to become associated with the financial statements.”

Is that correct?

MR.
GRAY: That
is correct.

MR.
WYDEN: . . . Mr.
Gray, you told the committee staff on May 29, 1987, that when you uncovered
evidence to support allegations of fraud that you decided to pack up your
workpapers and leave the ZZZZ Best audit site. How did your leaving without
telling anybody except the ZZZZ Best management and board of directors the reasons for leaving help the public and investors?

A
final twist to the ZZZZ Best scandal was an anonymous letter received by Ernst
& Whinney exactly one week after the firm resigned as ZZZZ Best’s
audi­tors. On that date, no one other than Ernst & Whinney and ZZZZ
Best’s officers was aware of the firm’s resignation. The letter, shown in
Exhibit 4, detailed a number of allegations suggesting that the ZZZZ Best
financial statements were fraudulent. According to the congressional testimony,
Ernst & Whinney for­warded this letter to the SEC on June 17, 1987.

I
am an individual having certain confidential information regarding the
financial condition of ZZZZ Best Co., Inc. I have read the prospectus and
your Review Report dated October 3,1986 and recognize you have not done an
examination In accordance with generally accepted auditing standards, but
that such audit will be forthcoming by you.

I
wish to make you aware of the following material facts which require you
to confirm or disaffirm:

1.The electric generators which appear on the balance sheet under
Note 6 as being purchased for $1,970,000 were purchased for scrap for less
than $100,000 thru intermediaries of ZZZZ Best and resold to ZZZZ Best at
the inflated value. The sole purpose was to boost the assets on the
balance sheet. These generators have never been used and have no utility
to the company.

2.Note 5 of the balance sheet discusses joint ventures and two
restoration contracts. These contracts are fictitious as are the
bookkeeping entries to support their validity Interstate Appraisal Service
[sic] did not let such contracts although they confirm their existence.
The same is true for the alleged $7,000,000 Sacramento contract and the
$40—100 million contracts with Interstate.

3.Further, checks made and passed between ZZZZ Best, its joint
venturers and some of its vendors are no more than transactions among
conspirators to support the validity of these restoration contracts.

4.Earnings reported by ZZZZ Best are being reported as Billings In
excess of costs and estimated earnings on restoration contracts. These
contracts do not exist nor do the earnings. This can be confirmed directly
by contacting the alleged insurance carriers as well as physical
inspec­tions as to the existence and extent of the contracts.

5.Billings and Earnings for 1985 and 1986 were fabricated by the
company before being presented to other accountants for certification.

Confirmation
of these allegations can be accomplished by a careful due diligence. Such
due diligence on your behalf is imperative for your protection.

Very
truly yours,

B. Cautious (Signed)

COLLAPSE
OF ZZZZ BEST

When
the extremely negative and revealing article regarding Minkow appeared in the Los
Angeles Times in mid-May 1987, the collapse of ZZZZ Best was proba­bly
inevitable. Several years earlier, a homemaker had fallen victim to Minkow’s
credit card forgeries. Minkow had added a fraudulent charge to the credit card
slip the woman had used to make a payment on her account. Despite her
persis­tence, Minkow avoided repaying the small amount. The woman never forgot
the insult and industriously tracked down, and kept a record of, the individuals
who had been similarly harmed by Minkow. At the urging of this individual, a
re­porter for the Los Angeles Times investigated her allegations. The
woman’s diary eventually became the basis for the Los Angeles Times article
that, for the first time, cast doubt on the integrity of the “boy wonder”
who was the talk of Wall Street.

The
newspaper article triggered a chain of events that quickly spelled the end of
ZZZZ Best. First, a small brokerage firm specializing in newly registered
com­panies with suspicious earnings histories began short-selling ZZZZ Best
stock, forcing the stock’s price into a tailspin. Second, Ernst & Whinney,
ZZZZ Best’s law firm, and ZZZZ Best’s brokers began giving more credence to
the allegations and rumors of financial wrongdoing by Minkow and his associates.
Third, and most important, the article panicked Minkow and compelled him to make
a num­ber of daring moves that cost him even more credibility. The most
critical mistake was his issuance of the May 28, 1987, press release that
boldly reported record profits and revenues for his firm.

EPILOGUE

Among
the parties most criticized for their roles in the ZZZZ Best scandal was Ernst
& Whinney. Included in the congressional testimony into the ZZZZ Best fraud
was a list of ten “red flags” that the audit firm had allegedly overlooked
while examining ZZZZ Best’s financial statements (see Exhibit 5). In
testifying be­fore the subcommittee, Leroy Gardner, the West Coast director of
accounting and auditing for Ernst & Whinney, maintained that when all the
facts were revealed, his firm would be totally vindicated.

"The
ZZZZ Best situation proves at least one thing: a well-orchestrated fraud will
often succeed even against careful, honest, hard-working people. . . The facts
that have begun to emerge establish that Minkow along with confederates both
inside and out­side ZZZZ Best went to extraordinary lengths to deceive Ernst
& Whinney. For exam­ple, Thomas Padgett, an alleged conspirator, revealed
in a recent televised interview that Minkow spent $4 million to deceive Ernst
& Whinney during a visit to one of ZZZZ Best’s job sites. . . . Ernst
& Whinney never misled investors about the reliability of ZZZZ Best’s
financial statements. Ernst & Whinney never even issued an audit opinion for
ZZZZ Best. . We are not part of the problem in this case. We were part of the
solution. "

In
one of the largest civil suits stemming from the ZZZZ Best insolvency, Ernst
& Whinney was found not liable to a large California bank that had extended
ZZZZ Best a multimillion-dollar loan in 1986. The bank alleged that in granting
the loan, it had relied upon the review report issued by Ernst & Whinney on
ZZZZ Best’s financial statements for the three-month period ending July 31,
1986. However, an appellate judge ruled that the bank was not justified in
relying on the review report since Ernst & Whinney had expressly stated in
the report that it was not issuing an opinion on the ZZZZ Best financial
statements: “Ernst, be­cause it issued only a review report, specifically
declined to express an opinion on ZZZZ Best’s financial statements. The report
expressly disclaimed any right to rely on its content.”[5]

In
the late 1980s, the former stockholders of ZZZZ Best filed a large class action
lawsuit against Ernst & Whinney, ZZZZBest’s former
law firm, and ZZZZ Best’s former brokers. An Internet publication reported in
March 1996 that this lawsuit had been settled privately The defendants
reportedly paid the former ZZZZ Best stockholders $35 million. However, the
contribution of each defendant to the settlement pool was not disclosed.[6]

In
December 1994, Barry Minkow was released from prison. Minkow earned the
reduction in his twenty-five-year prison sentence for “good behavior and
ef­forts to improve himself.”[7]These efforts included earning by correspondence bachelor’s and
master’s degrees in religion from Liberty University, the univer­sity founded
by Jerry Falwell. Shortly after his release from prison, Minkow began serving as
the associate pastor of a large evangelical church in a commu­nity near his
hometown of Reseda. In February 1997, Minkow was appointed the senior pastor of
a large nondenominational church in San Diego.

Besides
his pastoral duties, Minkow presents lectures and seminars across the United
States on how to prevent and detect financial fraud. Minkow has spoken to groups
of CPAs, educational institutions, and, most notably, the FBI Academy at
Quantico, Virginia. Many of the anecdotes included in Minkow’s presentations
are drawn from his autobiography Clean Sweep, which was published in 1995
by Thomas Nelson Publishers. Finally in 1996, Minkow began hosting a syndicated
radio talk show in which he discusses his personal views on financial and
spiri­tual matters. By late 1997, approximately forty radio stations scattered
across the nation broadcast Minkow’s talk show.

1.The amounts called for by the insurance restoration contracts were
unrealistically large.

2.The number of multimillion-dollar insurance restoration contracts
reportedly obtained by ZZZZ Best exceeded the total number available
nationwide during the relevant time period.

3.The purported contracts failed to identify the insureds, the
insurance companies, or the locations of the jobs.

4.The contracts consisted of a single page, which failed to contain
details and specifications of the work to be done, such as the square
yardage of carpet to be replaced, which were usual and customary in the
restoration business.

5.Virtually all of the insurance restoration contracts were with the
same party

6.A large proportion of the ZZZZ Best insurance restoration contracts
occurred immediately, and opportunistically, prior to a planned offering
of stock.

7.The purported contracts provided for payments to ZZZZ Best or
Minkow alone rather than to the insured or jointly with ZZZZ Best and the
insured, contrary to the practice of the industry.

8.The purported contracts provided for payments by the insurance
adjustor contrary to normal practice in the industry under which payments
are customarily made by the insurance com­pany directly to its insured or
jointly to its insured and the restorer.

9.ZZZZ Best’s purported gross profit margins for its restoration
business were greatly in ex­cess of ~he normal profit margins for the
restoration industry.

10.The
internal controls at ZZZZ Best were grossly inadequate.

[1]This
and all subsequent quotations, unless indicated otherwise, were taken from
the follow­ing source: U.S. Congress, House, Subcommittee on Oversight and
Investigations of the Committee on Energy and Commerce, Failure
of ZZZZ Best Co. (Washington, D.C.: U.S. Government Printing Office,
1988).